The retrenchment in the market has Ahn and his team lowering their forecasts for gold over the next three months from $1770 to $1700 and cutting their forecasts for 6-12 months out from $1770 to $1650. They are also lowering their estimated average gold price in 2013 to $1675 from $1750.

Ahn says the team's forecast is largely dependent on one factor that is overwhelmingly driving gold prices right now: the strength (or weakness) of the U.S. dollar. He writes, "the persistent importance of the dollar exchange rate in driving gold returns even beyond other classic factors is remarkable."

The chart below shows gold's correlation to dollar weakness, represented by the dark blue line. It also shows that gold prices display little or no correlation with the VIX – an index that measures S&P 500 volatility and is commonly referred to as the market's "fear gauge" – nor are they really correlated with investment flows into gold ETFs, or even inflation expectations.

Changes in inflation expectations matter a bit, but not as much as the dollar:

Meanwhile, the negative correlation between real interest rates and gold returns seems to have broken down over the course of the past year:

The bottom line, Ahn writes, is that "going forward, the dollar’s likely trajectory in 2013 should be scrutinized given its primacy in determining gold returns."

That is why Citi is lowering its gold price forecast (emphasis added):

Our model assumes a +1.2% appreciation in the dollar against a major currency-weighted basket to the end of 2013, also real interest rates at zero, and nominal CPI inflation at +1.9%.

Given the high and resilient negative relationship between the US dollar and nominal gold returns, the model assigns a very high 70% weight on dollar drivers, and only a 20% weighting on ETF flows and a 5% weight on real interest rates and inflation respectively, resulting in a forecast for a -4.2% annualized weakening of nominal gold prices to year-end.